Revealed: the hornet and the sting which are stopping us learning the truth about the collapse of HBOS

By Ian Fraser

Published: Sunday Herald

Date: February 26th, 2012

Results released last Friday showed a sea of red ink engulfing the state-rescued Lloyds Banking Group. Trumpeted at the time of its September 2008 formation as the “bank for Britain”, the 41%-taxpayer owned business unveiled annual losses of £3.5 billion for 2011, nearly double those RBS announced the previous day.

With the commentary focusing on the fallout from payment protection insurance (PPI) scandal, and bleak economic conditions helping to dash chief executive António Horta-Osório’s hopes of achieving a return-on-equity of more than 12.5% by 2014, it is no surprise that few noticed a bland statement buried on page 195 of the 204-page results news release.

In a section titled “Contingent liabilities and commitments” Lloyds referred to “enforcement proceedings against Bank of Scotland plc in relation to its corporate division pre-2009. The proceedings are ongoing and the group is co-operating fully. It is too early to predict the outcome or estimate reliably any potential financial effects of the enforcement proceedings…”

Here, then is the answer to the real story of the near collapse of HBOS and (subsequently) Lloyds and about why Lloyds’ future prospects remain so opaque. The three sentences hold the key to understanding why the Financial Services Authority, despite much prodding from Parliament’s Treasury Select Committee, considers itself incapable of producing a report into the reasons for the September 2008 collapse of the Edinburgh-based institution, which carried 300 years of Scottish commercial history.

For all the widespread criticism of the influence of Fred Goodwin’s lawyers and others, the FSA’s December 2011 report into the reasons for the collapse of RBS went some way towards creating “closure” for those affected by the October 2008 near-collapse of HBOS’s larger rival. But the FSA, chaired by Lord Turner, last month indicated that, where HBOS is concerned, and despite promises to the contrary, no such closure is going to be possible for the foreseeable future.

Adair Turner told the Treasury Select Committee last month that it’s so-called “enforcement proceedings” might be prejudiced if the regulator were to embark on researching and writing a comprehensive report on reasons for HBOS’s collapse, including an exploration of the FSA’s own failure to properly regulate and supervise the Edinburgh-based institution.

Turner, a fleet-footed former vice-chairman of the investment bank Merrill Lynch Europe, who has been FSA chairman since September 2008, told MPs: “We should produce a report, or somebody should produce a report on HBOS. In timing terms, we have the complication…that we have an enforcement process in place…and until that is produced we cannot produce the report.

“In summary, I believe that we should produce something on HBOS which is equivalent to [the RBS report]. The good news is it should be shorter, because it is a simpler business…”

Well up to a point. The enforcement action to which Turner referred is understood to include ‘Operation Hornet’ a major fraud investigation led by Thames Valley Police and the UK’s Serious Organised Crime Agency, which began after an in-depth Sunday Herald report in November 2008.

Hornet is investigating alleged money laundering, corruption and large-scale fraud linked to the “distressed assets” division of HBOS’s Bank of Scotland Corporate unit, which came under the direction of the well-connected banker Peter Cummings, centred on its Reading branch. A total of nine people have been arrested so far but none have yet been charged with any offence. No charges or allegations have been made against Cummings in relation to the Reading affair or any other matter.

Suspects in the case are alleged to have siphoned off and laundered an estimated £1bn lent by HBOS to up to 200 customer accounts. They are also alleged to have expropriated assets worth scores of millions and, in a series of administrations and other deals, were allowed by the bank to take ownership of many of the surviving assets.

Thames Valley Police last night declined to comment on the ongoing police inquiry.

In June 2010 the FSA confirmed it had commenced its own enforcement probe investigation into the HBOS Reading scandal, under section 168 of the Financial Services and Markets Act 2000. The FSA also continues to pursue various other investigations and enforcement proceedings into the wider HBOS group, with a particular focus on its corporate department.

After creating a complex lattice-like network of joint-venture companies with often high-profile borrowers in “frothy” sectors including property development, retail and private equity, Cummings and his team lent out a staggering £116 billion.

Cummings, already a director of various HBOS subsidiaries and off-balance-sheet-vehicles including Uberior Investments, became a director of some 147 of the joint venture companies in which HBOS had or has significant stakes, and to which it also lent many billions of pounds. The blurring of the boundaries between lender and borrower (with Cummings chairing the credit committee that weighed up whether or not to lend to companies 49% owned by the bank, on whose boards Cummings or other HBOS executives sat) led at best to the mispricing of risk and at worst to serious conflicts of interest.

The partners in HBOS’s galaxy of joint-ventures included well-known entrepreneurs such as Geoff Ball of Cala, Sir Rocco Forte of RF Hotels, Sir Philip Green of Arcadia and Top Shop, Sir Tom Hunter of West Coast Capital, Sir David Murray of Murray International Holdings, Paul Kemsley of Rock Investments, John Kennedy of Kenmore, Kevin McCabe of Teesland and Scarborough Development Group, Donald Macdonald of Macdonald Hotels, Sandy Orr of City Inns, the Reuben Brothers of Sapphire Retail Fund, David Sutherland of Tulloch and Iain Wotherspoon of Kilmartin. None of these individuals is known to be connected to Operation Hornet and no suggestion of impropriety has been made against them at any time.

After Lloyds’ black horse had saddled itself with Cummings’ poisonous legacy Tim Tookey, finance director of the enlarged group, concluded that an astounding £80bn or 69% of the £116bn Peter Cummings and his team had lent was “outside Lloyds TSB’s risk appetite”. One of the issues was that some of the loans had been dressed up as equity or hybrid capital in order to mislead regulators and enable HBOS to minimise the amount of loss-absorbing capital it needed to set aside.

Business people have been urging the FSA to properly investigate alleged unorthodox activities inside HBOS’s corporate lending arm since as early 2005.

The Sunday Herald has obtained a copy of a letter dated February 21, 2005 from one Scottish businessman asking the FSA “whether the operations of a secret bank account held in the British Virgin Islands, called Charlotte 18, was acting in the best interests of the customers and shareholders of The Bank of Scotland … Were money laundering processes and procedures being clearly followed?”

The letter also asked whether it was appropriate that the bank was using “assets to cover up the bad debts caused by the collapse of a company run by the former managing director of the Bank of Scotland”. Separately the letter raised concerns about the dual role of Sir James Crosby as chief executive of HBOS and as a director of the FSA.

Like others, the complaint fell on deaf ears at the FSA’s Canary Wharf HQ. The regulator responded by saying that it did not police “business models”. Since the 2008 banking crisis, the regulator has marginally toughened up its act and appears to have gained the beginnings of an appetite for probing the darker corners of the labyrinthine network of joint venture companies formed under Cummings’ rule.

It therefore came as a surprise when, last year, it emerged that the FSA had attempted to persuade Peter Cummings to agree to a voluntary ban from working in the City in exchange for dropping its investigation into his time as HBOS’s head of corporate banking. Cummings refused to accept the deal, saying that if any evidence of wrongdoing were to be found, he should be prosecuted accordingly and if it were not, the regulator should clear his name. It was also reported in January that Cummings was fighting with the regulator to prove that the whole HBOS board, including its former chairman Lord Stevenson, shared responsibility for the duff loans.

Julian Stevens, managing partner of Bristol-based financial advisory firm Harvest IFM, who like many IFAs is disillusioned by what he sees as the FSA’s wilful blindness to alleged frauds inside large banks, believes that the regulator favours such a deal to avoid its own regulatory failures being brought further into the limelight.

Stevens said: “The reason the FSA doesn’t want to go to court is that its own failings would very probably come under the spotlight so, by offering a deal, it gets the other side alone to admit culpability and pay up without anybody else finding out about the extent to which its own regulatory negligence contributed to things going as badly wrong as they did.”

In November 2009, it also emerged that the FSA was conducting a supervisory review scrutinising disclosures made by HBOS’ board to shareholders and investors prior to the HBOS rights issue in 2008.

Leading Treasury Select Committee member Michael Fallon disputes Turner’s assertion that enforcement proceedings preclude a wider overview-style report into what went wrong at HBOS. Fallon, who is also deputy chairman of the Conservative Party, said the delay into publishing a report into HBOS’s collapse is unacceptable.

He told the Sunday Herald: “Most members of the Treasury committee were furious at the FSA’s initial failure to publish a proper report into RBS. Having won that round, there’s now immense frustration at the length of time the FSA is taking to produce a report on HBOS.”

“If the enforcement action means we’re going to wait for two years before a comprehensive HBOS report can be produced,” said Fallon, “then I would say there’s a very strong case for the production of a partial report focusing on the regulatory side.”

Fallon, MP for Sevenoaks since 1997, added that such a report should “focus on identifying where the regulatory failures occurred”.

He said: “the FSA must, surely, be able to distinguish between enforcement proceedings relating to the actions of officers and former officers of the bank, which could culminate in court cases which could take months if not years, and making clear where its own regulatory failures occurred. We need to know whether there was inexcusable regulatory oversight.”

Another member of the Treasury select committee, Jesse Norman MP, agreed that it ought to be possible to produce an overview report into the reasons for the collapse of HBOS, and the related regulatory failures at the FSA, before the on-going enforcement and criminal proceedings are completed.

He cited the report conducted by Lord Bingham into the collapse of the Bank of Credit and Commerce International (BCCI) in 1991-92 which ended up being heavily focused on the supervisory role of Bank of England. “That was a model of its kind. There was no requirement to subpoena anyone and everyone was treated confidentially. The related criminal proceedings were not settled for a decade or more”.

One senior Scottish businessman said: “The rot set at Bank of Scotland in when the likes of Gavin Masterton and Peter Cummings started handing millions of pounds to their pals, without doing much in the way of due diligence.

“Remember that any banker who lends money to a business that is trading whilst insolvent – meaning, a business that is unable to pay its bills when they fall due – might be considered to be complicit in criminal acts. Any director of a bank that kept insolvent companies – including football clubs – afloat in this way was recklessly putting shareholders and depositors’ money at risk.”

The case for a public inquiry

Last month Turner as good as admitted that the FSA may not be the appropriate body to investigate the collapses of banks that it failed to adequately regulate. On January 30, he told the Treasury Select Committee that it may not bee too late launch a public inquiry into all of the UK’s bank failures, including those of RBS and HBOS.

Turner told MPs: “You could argue that if we could all roll it back to 2009, we ought to have launched a Royal Commission, which would have looked at absolutely everything, including each of the banks that failed, all together rather than one by one, and at the role of all three authorities [Treasury, Bank of England and FSA]. I think there could be merit in that at some stage.

This added weight to growing calls for a Leveson-style public inquiry into banks that failed. Others who have called for such an independent no-holds-barred inquiry include Tony Shearer, former chief executive of Kaupthing Singer & Friedlander, Paul Moore, former head of regulatory risk at HBOS, and the former Labour spin doctor Alistair Campbell.

In their view, Britons will never regain trust in their banks until the reasons for their failures are properly investigated, and from a wholly independent and unbiased standpoint.

Writing in his blog Campbell said: “The consequences [of the UK’s bank failures] have been greater and for more people than the phone hacking scandal which has rightly led to an inquiry into the practices of the modern media …

“I expect that one day [David Cameron] will have to set up a banking inquiry too. There has been no sense of closure on what happened … it could look at the whole picture – the role of politicians, regulators, credit ratings agencies, bankers, the lot.
“Unless it happens, and unless it leads to change the public anger will not subside, the politicians will continue to respond to it in a piecemeal way, and we’ll end up learning next to nothing.”

Pat McFadden Scots-born Labour MP for Wolverhampton Southeast and another member of the Treasury Select Committee, said the danger in allowing the FSA to conduct inquiries into UK bank failures was that it ended up with a lot of “self-justification”.
McFadden said: “When a regulator does these sorts of reports, the temptation is for it to place the blame in places other than on its own doorstep”.

Julian Stevens, managing partner of Bristol-based financial advisory firm Harvest IFM and a long-standing critic of the FSA, said he would welcome a Leveson-style inquiry into the banking crisis. He said: “That would be a good idea but it would only have real validity if it was ruthlessly impartial.”

An edited version of this article was published as the Business Focus on pp40-41 of the Sunday Herald on February 26th, 2012 (original article not yet online)

1 Comment for “Revealed: the hornet and the sting which are stopping us learning the truth about the collapse of HBOS”

[…] elsewhere. I have explored those who benefited from Cummings’ largesse in greater detail in The hornet and the sting), even as cannier lenders were running for the hills. The FSA report said:- “In the first half of […]